Changes anticipated in Russian transfer pricing rules
Background
There have been a number of attempts at improving Russia's transfer pricing legislation over the last few years. The current version of the draft law is to a large extent based on an earlier version, which was published on the Ministry of Finance's official website in 2007. Given the period of gestation, and the apparent political will to see a change to the transfer pricing rules, it seems quite possible that an end to the story is in sight, and that the draft legislation will finally be enacted in more or less the current form.
The amendments, if enacted, would completely replace Articles 20 and 40 of the Russian Tax Code and bring into effect a number of essential changes. Significantly, the suggested amendments would bring the rules much more into line with OECD transfer pricing principles than the current rules. Furthermore, the draft law includes considerably more detail on how the rules work in practice, and this may simplify their application by both taxpayers and tax authorities.
Definition of related parties
The definition of related parties would remain intact. Parties are related (or "affiliated") if one party may influence the conditions or the results of transactions performed by another party, or the results of its activity. Nevertheless, the courts retain the right to treat parties to a transaction as being related on other grounds. In addition, taxpayers may declare themselves to be related parties.
Other amendments concern particular cases of affiliation, which is extended to cover the following:
- Companies with the same (or related) owners, if the share of their participation is more than 20 percent;
- A company and its CEO, or a member of its board of directors;
- Companies with the same CEO;
- A chain of individuals and companies, where each successive company or individual in the chain owns more than 50 percent of the subsidiary;
- A settler of trust management, trust manager and beneficiary, as well as trust manager and managed companies; and
- Companies or individuals affiliated with the representative of their counterparty, or having affiliated representatives.
List of controlled transactions
The list of controlled transactions would be revamped to include:
- Transactions between related parties, both cross-border and domestic (including supply chains involving third-party intermediaries). However, transactions between related parties in Russia would be subject to transfer pricing control only in particular cases:
- If the total volume of transactions with the same counterparty (or counterparties) exceeds RUB 1 billion during a calendar year; or
- If the transaction involves mineral resources subject to mineral extraction tax at an ad valorem rate; or
- If one of the counterparties is a 'unified tax on imputed income' or 'unified agricultural tax' taxpayer.
- Cross-border transactions in certain commodities that are traded on an official exchange, including crude oil and petrol products, ferrous and nonferrous metals, precious metals, and gems.
- Transactions between Russian tax residents and offshore tax residents (of jurisdictions specified in a Ministry of Finance blacklist previously issued in relation to the Russian participation exemption).
Pricing control is explicitly extended to cover transactions involving property rights, and rights over intellectual property, including brands. The transfer pricing rules would also cover transactions in which prices are set as a tariff or rate (including interest rates on bank loans, credits, and other debt instruments).
Transactions between members of a consolidated group of taxpayers would be excluded from transfer pricing control, although this assumes the introduction of a consolidated taxpayer regime (the legislation for this is also in draft form at present).
Comparability of transactions
The draft law includes a number of articles relating to the comparability of economic conditions under which transactions are made.
In particular, the functions of the parties to a particular controlled transaction – who is in charge of design, production, setup, repair, marketing, legal and financial support, consulting, etc. – may be taken into account. The comparability of transactions also depends on the risks incurred by the parties – industrial, economic, investment, environmental, etc. The availability of unique equipment, intellectual property, and even customer list may also influence transaction comparability.
The draft law also lists the particular conditions influencing the comparability of loans, credit, guarantees, and commission agreements.
Sources of information
The proposed amendments include a clear list of sources of pricing information that may be used in a transfer pricing analysis. Those sources include official exchange price quotations, Russian customs statistics, publicly available price statistics, companies' financial reports, and formal valuations. The list is open.
Prices regulated by the authorities and prices set according to the antimonopoly authorities' directives would be treated as the market price for tax purposes.
Transfer pricing methods
The general principles – that the price used in a transaction should be the one used for taxation purposes, and that this is assumed to be equal to the market price unless otherwise proved – would remain unchanged.
The strict hierarchy for applying transfer pricing methods would be abolished, although the comparable uncontrolled price method remains the preferred one. The draft law also states circumstances in which other transfer pricing methods may be applicable.
The list of methods and procedures for their application is changed significantly:
- The comparable uncontrolled price method should be applied when information on at least four similar transactions is available. The method involves a calculation of the range of market prices, which is similar to the interquartile range used in OECD methodology.
- The resale Price method means that the reseller's profitability should be compared with the profitability range in similar uncontrolled transactions.
- The processed product sale method is a new method similar to the resale price method, and should be applied if a base product is being processed.
- The cost plus method involves a comparison between the producer's profitability in relation to costs, and the cost profitability range in similar uncontrolled transactions.
- The comparable profitability method is a new method to be used if there is a lack of data necessary to use one of the above methods. The profitability of one party to a particular transaction that performs fewer functions, bears less risk, and does not own any intangible assets that influence the level of profitability is compared to a profitability range.
- The profit split method is a new method that would be used if the other methods are not feasible, or in the case of a close relationship between the parties to the transaction, or if certain unique factors affect profitability. The aggregate profit of all parties to the transaction is allocated between them according to special rules.
If the above methods cannot determine whether the price used in a single transaction can be considered the market price, the draft law allows the use of an independent valuation report.
Documentation and reporting requirements
An important proposed change is the requirement that taxpayers maintain special transfer pricing documentation. The draft law obliges taxpayers to prepare and retain documentation showing that the prices used in controlled transactions correspond to market prices. These documents should contain the rationale for the choice of transfer pricing method, calculations of the market price range or profitability range, the amount of income or expenditure relating to the transaction, and the economic benefit obtained from the transaction.
These rules would apply if the total amount of controlled transactions with the same counterparty (or counterparties) exceeds RUB 100 million (approximately EUR 2.5 million) per annum. In the future, this threshold would be gradually decreased to RUB 10 million (EUR 250,000). The documentation would have to be provided to the tax authorities at their request, but not earlier than 1 April of the year following the year in which the controlled transaction took place.
In addition, the taxpayer would be required to prepare a statement of controlled transactions and file it with the tax authorities on an annual basis.
Corresponding adjustments
If the tax authorities make a pricing adjustment resulting in additional tax, the other party to the transaction would obtain the right to make a corresponding adjustment in its profit tax and VAT bases.
Advance Pricing Agreements
The largest taxpayers would be able to conclude special agreements with the Federal Tax Service. These advance pricing agreements would fix the procedure for price determination and pricing in controlled transactions. Agreements may also include foreign tax authorities as parties to the agreements It is assumed that such agreements would protect taxpayers against tax authority challenges to pricing, and possible additional tax assessments as a result of price control. It is anticipated, however, that the provisions on advance pricing agreements would not enter into force before 1 January 2012.
Pricing control
The Federal Tax Service would obtain the right to conduct special audits of prices used in controlled transactions, i.e. whether they are in line with market prices. These pricing audits would not be related to regular tax audits, although the rules would be similar.
Specific penalties
The amendments introduce specific penalties for nonpayment or underpayment of taxes due to the application of transfer prices (40 percent of the outstanding tax), as well as for the failure to submit information (or submitting false information) on the controlled transactions (RUB 5,000). There also would be a special penalty for breaching the conditions of an advance pricing agreement (RUB 1.5 million).
Implications for taxpayers
As a result of the proposed new rules, taxpayers may need to undertake the following:
- Review relations with counterparties to identify transactions falling under price control;
- Review the relationship with counterparties in respect of major transactions to minimize risk;
- Analyze the functions performed by various companies in a group, as well as the risks borne by each of them;
- Benchmark comparable market prices and comparable profitability ranges;
- Prepare documentation supporting the choice of transfer pricing method;
- Consider changes to the flow of documentation supporting pricing decisions for tax purposes;
- Undertake additional reconciliations with counterparties to quickly identify price adjustments made by the tax authorities and effect relevant corresponding adjustments;
- Professional development of employees dealing with the tax authorities during price control reviews; and
- Thorough advance planning of transactions to minimize transfer pricing risk.
TAX NEWS - april 2010
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